Earn-Out
An earn-out is the part of an acquisition price that is paid later, and only if the business hits targets agreed at signing — usually revenue or EBITDA over one to three years. It bridges the gap between what the seller believes the business will do and what the buyer is prepared to pay for today.
- Also known as
- Earnout, Contingent consideration, Deferred consideration, KPI contingencies
- Used at
- agreed in the letter of intent, drafted in the sale agreement, paid one to three years after completion
- Binding
- yes; the formula, the accounting policies and the buyer's conduct covenants are all contractual
- Typical size
- 10–40% of the total price
- Typical measure
- revenue for a growing fintech, EBITDA for a profitable one; sometimes users, volume or a regulatory milestone
- Parties
- the buyer and the sellers, who usually stay on to run the business through the earn-out period
How an earn-out works in practice
Fintech valuations rest on growth that has not happened yet, and an earn-out is how a buyer pays for it only once it has. The letter of intent names a headline price; the sale agreement splits it into the cash at completion and a formula: so much for every euro of revenue above a threshold, capped at a maximum, measured over a defined period on defined accounting policies.
The formula is the easy part. The hard part is what happens to the business while the earn-out runs, because the seller's money now depends on decisions the buyer makes. If the buyer merges the acquired company into its own, moves its customers onto a group contract, raises its prices or cuts its sales team, the target may be missed for reasons that have nothing to do with the sellers. So the agreement carries conduct covenants: the buyer will run the business in the ordinary course, keep it as a separate profit centre, fund its budget, not divert its customers. The sellers get information rights and a dispute mechanism — usually an independent accountant whose decision on the calculation is final.
For a regulated business the earn-out often includes a milestone rather than a number: a licence obtained in a new market, or a scheme membership approved. Those are cleaner to measure and harder to manipulate.
Example
A payments company is sold for up to £25m: £17m at completion and an earn-out of £4 for every £1 of revenue above £6m in the first full year, capped at £8m. Revenue in that year reaches £7.6m, so the earn-out pays £6.4m and the sellers receive £23.4m in all. Had the buyer moved the company's largest merchant onto a group-wide contract booked elsewhere — which the conduct covenants forbade — revenue would have been £6.9m and the earn-out £3.6m, a £2.8m difference the sellers could have taken to the independent accountant.
Common mistakes
- A target measured on accounting policies the agreement does not fix, so the buyer's finance team decides what counts. - No conduct covenants, leaving the sellers exposed to every decision the buyer makes. - An earn-out on EBITDA in a business the buyer intends to invest in, where every hire cuts the sellers' payout. - Sellers treating the earn-out as certain money and the buyer treating it as unlikely, and neither writing down which. - A period too long: after three years the business is the buyer's, and the original sellers' contribution is unmeasurable.